Issue
Does a termination amount payable to the entity, a supplier under a hire purchase agreement, arising from the termination of a hire purchase agreement by the entity due to a default by the hirer, form part of the consideration for a taxable supply under section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act)?
Decision
No, the termination amount payable to the entity does not form part of the consideration for a taxable supply under section 9-5 of the GST Act.
The termination amount is payable in respect of damages and accordingly the payment is not consideration for a supply.
Facts
The entity enters into a hire purchase agreement on or after 1 July 2012 with a customer for the supply of goods. Under the hire purchase agreement the entity makes two supplies, a taxable supply of goods and a taxable supply of credit (the disclosed credit charges). Payments for these supplies are taxable, and are made to the entity in instalments.
The entity is registered for goods and services tax (GST).
The entity does not account for GST on a cash basis.
In a later tax period, there is a genuine dispute between the parties, the hirer defaults and the entity exercises its right to terminate the hire purchase agreement.
The entity has the right to repossess the goods and then sell or re-hire them. Any amount in arrears up to the date of termination remains payable.
Under the hire purchase agreement, the future outstanding instalments are no longer payable. To compensate the entity for any loss under the hire purchase agreement the entity is entitled to a termination amount. The termination amount is the discounted future outstanding amounts reduced by the net proceeds of resale or rehiring.
These events are illustrated in the following diagram. This ATO ID addresses event (1):
Reasons for Decision
Section 9-5 of the GST Act sets out the requirements that must be met for an entity to make a taxable supply. A transaction is only a taxable supply if there is consideration for a taxable supply (paragraph 9-5(a) of the GST Act).
When there is a default and termination under a lease agreement, the supply of hire or the right to possess the goods has come to an end and the damages payments that subsequently arise do not relate to this earlier supply. In contrast a hire purchase agreement 'is in commercial substance a method by which the 'hirer' purchases goods on deferred payment terms' (paragraph 197 of GSTR 2000/29). The legal form that is used to achieve the sale of goods on deferred terms generally 'involves bailment and an option to purchase' (paragraph 199 of GSTR 2000/29). After a hire purchase agreement has been terminated, both the right to possess the goods and any right or option to obtain legal title to the goods have been extinguished. In addition, any credit that was provided under the agreement has also come to an end.
Paragraph 72 of Goods and Services Tax Ruling GSTR 2003/11 explains that a termination payment made to compensate the genuine damage or loss flowing from early termination as a result of a default by the lessee is not consideration for a supply. This is the case even though the lessor brings the lease to an end by exercising the right to terminate the lease. GSTR 2003/11 does not deal specifically with hire purchase agreements, but the principles may have broad application depending on the individual facts (paragraph 2 of GSTR 2003/11).
When the hirer makes payments to compensate for loss of future instalments, these payments can no longer be characterised as consideration for the original supply of goods or credit under the agreement. While there are differences in both the commercial substance and legal form of leases and hire purchase agreements, the treatment of payments made after termination is comparable and the principles in GSTR 2003/11 can be applied to hire purchase agreements.
Applying paragraph 74 of GSTR 2003/11 to hire purchase agreements, a payment for damages includes amounts calculated with reference to putting the financier in the position it would have been in if the hire purchase agreement had been completed. The damages payable by the hirer may be calculated by reference to the future instalments (commonly adjusted to present values) less any net sale proceeds from sale of the goods by the entity. The termination amount is calculated under the agreement by reference to the discounted value of all future instalments less the net proceeds of the repossessed assets and is generally consistent with calculation illustrated in paragraph 74 of GSTR 2003/11. As such, the termination amount is a payment for damages, as one party (the hirer) has not met their obligations under the contract.
Therefore the termination amount payable to the entity, under a hire purchase agreement that has been terminated due to a default by the hirer, does not form part of the consideration for a taxable supply under section 9-5 of the GST Act. The termination amount is payable in respect of damages and accordingly the payment is not consideration for a supply.
Note: The termination amount does not include amounts in arrears that relate to instalments that had become due and payable before the termination date. Amounts in arrears are consideration for the supply of goods and the supply of credit made under the hire purchase contract and are not damages. If a termination amount included these amounts, it would be necessary to apportion the amount between the damages and the supply .